CU Tax Debate: Beyond U.S. Borders

Most Canadian credit union executives can't remember a time when they didn't have to pay a nominal tax on income. But in the near future, the 40-year-old credit union tax, like most taxes, will increase.

The current combined federal/provincial income tax, which mirrors Canada's small business deduction and includes an additional deduction for other earnings not covered under small business, varies by province from 11% to 15%. Those rates are scheduled to increase by 4% according to provisions in Canada's 2013 federal budget, passed on June 26, which calls for a five-year phase-out of what had been considered a preferential tax rate.

Gene Blishen, general manger of $42 million Mt. Lehman Credit Union in Mt. Lehman, B.C., spoke on a panel during the CU Water Cooler Symposium in Nashville in October. When the panel topic turned to tax reform, Blishen surprised attendees by speaking positively about Canada's tax on credit unions, saying it gives the industry more influence with lawmakers.

And, he said, it's a civic duty.

“As Canadians, we've never seen taxation as an evil, but as a necessity to build a civil society,” he said. “I see one aspect of taxation as the ability to take care of ourselves through a common goal.”

In Canada, the cost of taxation is added to the credit union balance sheet as an expense item, but the cost has been minimal to date, Blishen said. And since member dividends are paid before net income is established and taxes are assessed, Canadian credit unions reduce their tax burden by paying out more to members, a strategy that benefits all parties involved, he said.

But there is actually more to it than that, particularly concerning Canadian credit unions view that paying taxes is part of responsible “cooperative” citizenship.

“We're paying our fair share as cooperative entities and the corporate world can't point a finger at us and say that we're not,” Blishen said.

But Blishen admits there needs to be reciprocity in the dialogue to make sure that tax-paying entities have all the benefits as well as the financial burden, a key issue he believes is facing U.S. credit unions.

“If the banks want credit unions taxed, what do the credit unions expect in return?” Blishen asked. “I believe the U.S. regulation needs to be rethought.”

Others disagree, and Credit Union Central of Canada, the country's trade association, believes it will have a hard time reversing the new tax increase, according to World Council of Credit Unions’ Michael Edwards.

“Supporters say it gives their credit unions a seat at the table, but that's not true,” said Edwards, the international trade group's chief counsel and advocacy and governmental affairs vice president. “The new tax will be another headwind for small credit unions.”

Despite the attention, Canada is among a minority of credit union systems that pay income taxes. According to the recently issued 2012 Taxation Report, a member benefit produced by World Council, 70% of the 101 countries responding to a World Council survey reported paying no taxes on income.

Next Page: Most Credit Union Systems Untaxed

Only 30% of credit union systems are fully or partially taxed, with rates ranging from a low of 10% to a whopping 40% paid on non-cooperative transaction earnings like fees or commissions in Brazil.

Many of the taxed credit unions tend to be part of smaller systems in developing countries. In addition to Canada, the other developed systems being taxed include Poland and Australia, the later of which has shouldered 20 years of paying tax on net income as well as other taxes, Edwards said.

“Taxation has significantly affected the financial cooperative industry,” said Edwards, who recently visited Australia. “At one time they had about 400 credit unions and now they're down to around 100 financial cooperatives and no longer even use the credit union brand.”

On July 1, Abacus Australian Mutuals, the country's credit union trade association, changed its name to the Customer Owned Banking Association to better reflect the link binding its member institutions. The organization's membership includes the country's 82 credit unions, 7 building societies, 10 mutual banks, and 1 other related organization.

Despite the name change and a declining numbers of credit unions in Australia, Mark Degotardi, COBA's head of public affairs, said he respectfully disagrees with Edwards’ assertion. Australia's credit unions currently face several challenges, he said, but there also are significant strengths within the system.

“The one thing that tells the real story of customer-owned banking is the strength of our sector, not the number of institutions,” Degotardi said. “In 2002, our industry was made up of more than 200 institutions and around $40 billion in assets. Today our industry has half as many institutions, but has double the assets.”

In 1993, Australia's credit unions lost their tax-exempt status and became subject to a corporate tax. The tax was progressively introduced for credit unions starting 1995, and by 1998 they had transitioned to paying the normal corporate tax rates of 36%. The current 30% tax rate credit unions pay has been in place since 2001, reduced as part of a range of taxation reforms including the introduction that year of broad-based goods-and-services tax.

Australia's credit unions adjusted to taxation through planning and budgeting as they would any other business challenge, Degotardi said. In this case success appears to be less a matter of size than of business strategy.

“The performance of our members doesn't show a particular pattern relative to size,” Degotardi said. ”There are examples of strong performance amongst large, medium and small organizations.”

The Australian system is not without its challenges, not the least of which is the inability of mutual institutions to release tax credits, known as “franking credits,” to its members to offset their personal tax situation, something for-profit companies are allowed to do under law. Working on the principle that members should not be double-taxed, COBA is lobbying for regulatory changes that would allow the release of franking credits to members.

In addition, the government is currently considering the establishment of a Financial Security Fund to prevent future need for a financial bailout. Australia's banking sector, controlled by four major institutions, receives an effective taxpayer-funded advantage thanks to the banks’ too big to fail status. COBA is currently lobbying for the establishment of a more diverse and robust system approach to reduce the dominance of the institutions, reducing risk while not unfairly penalizing smaller institutions, Degotardi said.

“If a bank levy is to be introduced, COBA will seek to avoid a system where smaller players pay comparatively more than larger ones, delivering big banks a competitive advantage,” he said.

As to COBA's name change, Degotardi insisted the emphasis on customer ownership clearly communicates the competitive difference credit unions and other member groups offer in the current environment. The July 1 rebrand was fully accepted by members at the trade group's Oct. 29 annual general meeting.

“Many of our member institutions have been using customer-owned banking in their communications,” Degotardi said. “It serves as a much clearer descriptor for our industry.”

Edwards said considering credit union taxation may be easier in developed countries like Canada and U.S. than it would be in other parts of the world. Taxes are more burdensome among African and Latin American countries, in some instances requiring smaller credit unions to post a negative a return on assets because the tax rates are so high relative to net worth, Edwards said.

Credit unions in Kenya currently pay a 30% tax on net income. The government now wants to enact an additional tax on each transaction, a move that World Council is working in concert with member organization the Kenya Union of Savings & Credit Co-operatives Ltd. to oppose.

Canadian credit unions also want their government to reconsider their tax increase plan, if for no other reason than an unintended glitch in the law could send unsuspecting institutions spiraling into a much higher tax bracket.

The idea of taxing credit unions at all is not a good one, especially in the U.S., Edwards stressed.

“The game plan for the bankers is to get rid of the credit union tax exemption and not give them any more powers,” Edwards said. “What happened to the savings and loan industry is what would happen to credit unions. Without the corresponding broad investment powers of for-profit institutions, we would get crushed.”

Blishen disagrees with the assessment, falling short of citing the success of Canadian credit unions as a case for taxation.

“I do realize this is a sensitive issue and a cloudy one as well,” Blishen said. “If you're going to pay tax, then you should be able to sit at the table and get the government to provide what you need to create a more effective system.